Health Care

One of the top-performing sectors, both in the US and Australia, is Health Care.

DJUS Health Care

The strength of a momentum strategy is the ability to identify and concentrate investment in outperforming sectors like this. Our S&P 500 Momentum strategy is overweight (40%) in this sector, with investments in Pharmaceuticals, Health Care Supplies and Biotechnology stocks.

Markets back on track

Threat of a Russian collapse roiled markets in early December, but the immediate crisis now seems to have passed.

Recovery of the S&P 500 above resistance at 2080 would indicate another advance , with a target of 2150*. Rising 13-week Twiggs Money Flow troughs indicate long-term buying pressure. Reversal below 2000 is most unlikely.

S&P 500 Index

* Target calculation: 2000 + ( 2000 – 1850 ) = 2150

A 10-year view of CBOE Volatility Index (VIX) suggests low to moderate risk typical of a bull market.

S&P 500 VIX

My favorite bellwether, transport stock Fedex, also underwent a correction. The long tail suggests buying pressure and breakout above the recent high would confirm a strong bull trend, indicating rising economic activity.

Fedex

Dow Jones Euro Stoxx 50 found support at 3000 and is likely to test 3300. Rising 13-week Twiggs Money Flow indicates buying pressure, but the index is likely to continue ranging between these two levels until tensions between Russia and Eastern Europe are resolved.

DJ Euro Stoxx 50

China’s Shanghai Composite Index is in a strong bull trend, having broken resistance at 2500, and is likely to test the 2009 high at 3500. Rising 13-week Twiggs Money Flow indicates strong (medium-term) buying pressure.

Shanghai Composite Index

I continue to question China’s ability to sustain this performance, given their poor economic foundation.

Japan’s Nikkei 225 Index breakout above its 2007 high of 18000 would signal an advance to 19000*. Rising 13-Week Twiggs Money Flow indicates strong buying pressure. Index gains are largely attributable to rising inflation and a weaker yen.

Nikkei 225 Index

* Target calculation: 18000 + ( 18000 – 17000 ) = 19000

India’s Sensex found support at 27000. Recovery above 28000 would suggest another advance. Breakout above 29000 would confirm a target of 31000*.

Sensex

* Target calculation: 29000 + ( 29000 – 27000 ) = 31000

ASX 200 performance remains weak. Breach of the recent descending trendline suggests that the correction is over, but only breakout above 5550 would complete a double-bottom formation, suggesting a fresh advance. Rising troughs on 13-week Twiggs Money Flow indicate medium-term buying pressure. Reversal of TMF below zero, or breach of support at 5000/5150, is now less likely, but would warn of a down-trend.

ASX 200

* Target calculation: 5500 + ( 5500 – 5000 ) = 6000

Murray has endorsed macroprudential | Macrobusiness.com.au

Posted by Houses and Holes
At 12:52pm on December 8, 2014
Published with permission from Macrobusiness.com.au.

From Callam Pickering:

The one glaring problem with the Financial System Inquiry is that it didn’t push hard for the introduction of macroprudential policies. That takes the heat off both the RBA and APRA.

The truth is that higher capital requirements — combined with higher risk weighting on mortgages and tax reform — would have a similar (potentially larger) effect as macroprudential policies. In the long term financial system and tax reform is clearly the better approach to creating an efficient and sustainable housing and financial sector, but these reforms will take longer to implement.

That’s right. Murray’s principle recommendations are macroprudential. APRA is now free (and is being urged) to implement higher capital requirements. They do not require anything from government to go ahead. This is basically the model of MP envisaged by Prof Ross Garnaut.

A more interesting question is whether or not APRA will still act on specific areas of risk such as interest-only loans. These are a menace, as the US bust showed, and are surging. Murray did not mention them, being too granular, but said the following on MP more particularly:

The global financial crisis (GFC) prompted policy makers and regulators around the world to reconsider their approach to maintaining financial stability. Some countries at the epicentre of the crisis have since expanded their prudential perimeters and adopted more formal and centralised institutional arrangements. This includes establishing single entities with responsibility for macro-prudential regulation. Australia has long adopted what could be called a ‘macro-prudential’ approach to supervision under the rubric of financial stability. Yet, Australia’s institutional structure is relatively informal and decentralised. The Reserve Bank of Australia (RBA) and APRA each have responsibility for financial stability. However, most macro-prudential tools can only be deployed by APRA. This places a strong premium on cooperation between the two agencies.

Against the background of developments overseas, the Inquiry has considered whether Australia should change its institutional arrangements for making and implementing financial stability policy.

However, the Inquiry does not see a strong case for change in this area. Although approach has advantages and disadvantages, alternative institutional approaches are yet to be tested — as indeed is the effectiveness of many macro-prudential tools. For this reason, the Inquiry recommends no fundamental change to the current institutional arrangements for financial stability policy and no change to the prudential perimeter at this time.

That is neither here nor there and APRA will still be free to raise capital requirements for specific loans if it sees fit.

Australian banks rally on Murray Report

The ASX 200 Financial sector (ex-REITs) responded well to release of David Murray’s report into the financial services industry. As the largest constituent of the ASX 200 index, comprising more than one-third of market capitalization, sector performance is critical in determining future direction of the broader index. Breach of resistance at 7220 suggests that the correction is over. Follow-through above 7400 would confirm a fresh primary advance.

ASX 200 Financial ex Property

David Murray’s Financial System Inquiry

The Final Report of the Financial System Inquiry, led by ex-Commonwealth Bank CEO David Murray, calls on Australian banks to become “unquestionably strong” to prevent another financial crisis. The FSI calls for increased bank capital in the form of common equity, with capital ratios increasing from an average of 9.1% to the 12.2% threshold for the top quartile of international banks. The FSI also proposes that banks increase their average risk-weighting for home mortgages to 25-30% compared to current weightings as low as 15%.

Chris Joye from the AFR estimates that the first proposal would require about $21 billion in new capital, while increased risk-weighting would require an additional $15 billion. There may be some overlap between the two, but the combined requirement is likely to be more that $30 billion.

Impact on consumers is likely to be negligible. The FSI projects that a 1% increase in bank capital ratios would increase the weighted cost of capital by 6 basis points (0.06%) because of the higher cost of equity capital.

Bank Funding Costs with Increased Capital

But this does not take account of lower risk premiums required, for debt and equity, when capital is increased. A reduction of debt funding costs to 3.65% and equity to 14.75% would offset the increase in equity capital; so the actual cost increase may be considerably smaller.

A resilient banking system would not only avoid significant losses of GDP (as high as 158 percent) in the event of a financial crisis, but would save up to 900,000 jobs according to the FSI. In addition, reduced risk of a government bailout would minimize the threat to government debt levels and Australia’s AAA credit rating. Banks would also benefit through improved profitability and stronger growth prospects.

My concerns with FSI are mainly long-term. Raising capital ratios to the top quartile of international banks would certainly improve the resilience of Australian banks, but this is a moving target. We can expect average capital held by international banks to increase as other countries conduct their own reviews into the adequacy of bank funding. Also, leverage ratios (ignoring risk-weighting) remain low and should be progressively lifted towards a long-term goal of 6 to 8 percent. Reliance solely on risk-weighted capital ratios can encourage industry-wide concentration in low-risk-weighted assets which in turn will elevate risk. Lastly, bail-in bonds are dangerous — any attempt at conversion would destroy creditor confidence in the banking system with far-reaching repercussions — and should be discouraged.

I believe that stronger capital ratios are a win for both Australian taxpayers and bank shareholders. Implementation of the FSI recommendations would be a major advance towards building a resilient and sustainable banking sector.

A long-term view

Better than expected US jobs data and strong German factory orders helped to rally markets Friday. Also, ECB chief Mario Draghi’s Thursday announcement is seen as supporting broad-based asset purchases (QE) early in 2015. A long-term view of major markets may help to place current activity in perspective.

The S&P 500 continues a strong advance, with rising 13-week Twiggs Money Flow indicating medium-term buying pressure. Long-term and medium targets coincide at 2250* and we should expect further resistance at this level.

S&P 500 Index

* Target calculation: 1500 + ( 1500 – 750 ) = 2250; 2050 + ( 2050 – 1850 ) = 2250

CBOE Volatility Index (VIX) continues to indicate low risk typical of a bull market.

S&P 500 VIX

Germany’s DAX broke resistance at its earlier high of 10000, suggesting a further advance. Recovery of 13-week Twiggs Momentum above zero indicates continuation of the up-trend. The long-term target is 12500*, though I cannot see this being reached until tensions in Eastern Europe are resolved.

DAX

* Target calculation: 7500 + ( 7500 – 2500 ) = 12500

The Footsie is testing long-term resistance at 6900/7000. Respect of the zero line by 13-Week Twiggs Money Flow indicates long-term buying pressure. Breakout above 7000 would signal a fresh primary advance, with a long-term target of 10500*.

FTSE 100

* Target calculation: 7000 + ( 7000 – 3500 ) = 10500

China’s Shanghai Composite Index broke resistance at 2500 and is likely to test the 2009 high at 3500. Rising 13-week Twiggs Money Flow indicates strong (medium-term) buying pressure.

Shanghai Composite Index

Japan’s Nikkei 225 Index is testing resistance at its 2007 high of 18000. 13-Week Twiggs Money Flow respecting the zero line indicates long-term buying pressure. Breakout would signal another primary advance. A long-term target of 28000* seems unachievable unless one factors in rising inflation and continued devaluation of the yen.

Nikkei 225 Index

* Target calculation: 18000 + ( 18000 – 8000 ) = 28000

Weak ASX 200 performance is highlighted by the distance below its 2007 high of 6850. Falling commodity prices have retarded the recovery and are likely to continue for some time ahead.

The 2005-2008 Australian commodities boom was squandered, damaging local industry and hampering the current recovery. Norway successfully weathered a similar commodities boom in the 1990s, protecting local industry while establishing a sovereign wealth fund that is the envy of its peers. Their fiscal discipline set a precedent which should be followed by any resource-rich country looking to navigate a sustainable path through a commodities boom and avoid the dreaded “Dutch Disease”.

Respect of support at 5000 would indicate the primary up-trend is intact — but declining 13-week Twiggs Money Flow indicates selling pressure. Reversal of TMF below zero or breach of support at 5000/5150 would warn of a down-trend.

ASX 200

* Target calculation: 5000 + ( 5000 – 4000 ) = 6000

The daily chart shows a slightly improved perspective. 21-Day Twiggs Money Flow oscillating around zero signals indecision. Recovery above 5400 would suggest the correction is over. But reversal below 5200 is as likely and would warn of a test of primary support at 5120/5150.

ASX 200 daily

A tale of two economies

Stock markets in Western Europe and Asia are rallying on the strength of falling oil prices, joining the US in a bull trend. But primary producers, largely dependent on commodity exports, are likely to suffer as a result of falling prices. Australia is no exception.

The S&P 500 continues a primary advance. A conservative target would be 2200*. Rising 13-week Twiggs Money Flow indicates medium-term buying support. Reversal below 2000 is unlikely, but would warn of another correction.

S&P 500 Index

* Target calculation: 2000 + ( 2000 – 1800 ) = 2200

CBOE Volatility Index (VIX) indicates low risk typical of a bull market.

S&P 500 VIX

Germany’s DAX is testing resistance at its earlier high of 10000. Recovery of 13-week Twiggs Money Flow above the declining trendline suggests medium-term buying pressure. Breakout above resistance would offer a conservative target of 11000*. Reversal below 9000 is unlikely, but would warn of a primary down-trend.

DAX

* Target calculation: 10000 + ( 10000 – 9000 ) = 11000

The Footsie is also testing long-term resistance on the monthly chart — at 6900/7000. The sharp rise on 13-Week Twiggs Money Flow indicates strong medium-term buying pressure, but resistance at the December 1999 high is likely to be solid. Reversal below 6500 remains unlikely.

FTSE 100

China’s Shanghai Composite Index cleared resistance at 2440/2500, signaling a primary up-trend. 13-Week Twiggs Money Flow respect of its rising trendline confirms (medium-term) buying pressure. I remain wary of China. The recent rate-cut by the PBOC is cause for concern, not jubilation.

Shanghai Composite Index

* Target calculation: 2500 + ( 2500 – 2000 ) = 3000

Japan’s Nikkei 225 Index is headed for long-term resistance at 18000. 13-Week Twiggs Money Flow oscillating above the zero line indicates long-term buying pressure. Reversal below 16500 is unlikely.

Nikkei 225 Index

* Target calculation: 16000 + ( 16000 – 14000 ) = 18000

The ASX 200 is undergoing another correction. Respect of support at 5250/5300 would indicate the primary up-trend is intact — but 13-week Twiggs Money Flow reversal below zero warns of strong selling pressure. Breach of support is likely and would warn of a test of 5000.

ASX 200

* Target calculation: 5650 + ( 5650 – 5300 ) = 6000

ASX 200 rallies despite weaker AUD

The Australian Dollar followed through below support at $0.8650, confirming a (primary) decline with a target of $0.80*. Declining 13-week Twiggs Momentum below zero strengthens the bear signal. Recovery above $0.8650 is unlikely.

AUDUSD

* Target calculation: 0.87 – ( 0.94 – 0.87 ) = 0.80

The ASX 200 respected support at 5300. Follow-through above 5450 would suggest a fresh advance. A 21-day Twiggs Money Flow trough at zero indicates short-term buying pressure. Reversal below 5300, however, would test primary support.

ASX 200

The ASX 200 Financial sector (ex-REITs) is the largest constituent of the ASX 200 index. 13-Week Twiggs Money Flow oscillating above zero suggests healthy buying pressure despite the Murray Inquiry’s likely call for increased bank capital [AFR]. The sector index successfully tested support at 7050, indicating another test of 7400.

ASX 200 Financial ex Property

Markets rebound except for ASX

  • US stocks continue their bull-trend
  • European stocks strengthen
  • China likewise
  • ASX Energy and Materials sectors under pressure

The S&P 500 broke through the upper border of its broadening wedge formation, signaling a fresh advance with a target of 2300*. Rising 13-week Twiggs Money Flow indicates medium-term buying support. Reversal below 2000 is unlikely, but would warn of another correction.

S&P 500 Index

* Target calculation: 2050 + ( 2050 – 1800 ) = 2300

CBOE Volatility Index (VIX) at 13 continues to reflect low risk typical of a bull market.

S&P 500 VIX

Germany’s DAX broke through resistance at 9400/9500, signaling another test of 10000. Rising 13-week Twiggs Money Flow refllects medium-term buying pressure. Reversal below 9400 is unlikely at present, but would warn of another test of primary support at 9000.

DAX

* Target calculation: 9000 – ( 10000 – 9000 ) = 8000

The Footsie is also headed for a test of its long-term high at 6900/6950. The sharp rise on 13-Week Twiggs Money Flow indicates strong medium-term buying pressure. Reversal below 6500 is unlikely.

FTSE 100

China’s Shanghai Composite Index respected support at its 2013 high of 2440, signaling a fresh advance. 13-Week Twiggs Money Flow respect of its rising trendline confirms (medium-term) buying pressure.

Shanghai Composite Index

* Target calculation: 2400 + ( 2400 – 2300 ) = 2500

The ASX 200 is weaker, undergoing another correction. Respect of support at 5250/5300 would indicate the primary up-trend is intact — as would a 13-week Twiggs Money Flow trough above zero. Penetration of primary support at 5120/5150, however, would signal a primary down-trend.

ASX 200

* Target calculation: 5650 + ( 5650 – 5300 ) = 6000

ASX 200 Materials (15.7%) and Energy (6.0%) sectors have commenced a down-trend. This is in sharp contrast to the Financial (46.2% including REITs) and Health Care (5.2%) sectors which continue in a healthy up-trend. It is possible for the first two sectors, with a combined weighting of 21.7%, to reverse the broad index, but is not likely unless the contagion spreads to the Industrial and Financial sectors. Increased risk-weightings for home mortgages and stronger capital ratios for major banks are likely recommendations of the Murray inquiry. These will improve the long-term strength and growth prospects for Financials, but a negative reaction in the short-term could tip the sector into a down-trend.

ASX 200 sectors

ASX under pressure

The S&P 500 continues to test resistance at 2050, the upper bound of the broadening wedge. Rising 13-week Twiggs Money Flow suggests buying pressure. Breakout would offer a target of 2250*. Reversal below 2000 is less likely, but would warn of another correction.

S&P 500

* Target calculation: 2050 + ( 2050 – 1850 ) = 2250

The CBOE Volatility Index (VIX) indicates low risk typical of a bull market.

S&P 500 VIX

Dow Jones Euro Stoxx 50 is testing resistance at 3140. Breakout would indicate an advance to 3300. 13-Week Twiggs Money Flow oscillating around zero suggests indecision. Respect of 3140 would test primary support at 3000.

Dow Jones Euro Stoxx 50

The Shanghai Composite Index retraced to test support at 2440, while declining 13-week Twiggs Money Flow indicates medium-term selling pressure. Reversal below the rising trendline at 2400 would warn of a correction, while respect would suggest trend strength.

Shanghai Composite

Hong Kong’s Hang Seng Index is weaker. Reversal below 23000 would warn of a test of primary support at 21200/21500. Twiggs Money Flow (13-week) reversal below zero would also be a strong bear signal.

HSI

The ASX 200 is undergoing another correction. Respect of support at 5250/5300 would indicate reasonable trend strength, but declining 21-day Twiggs Money Flow suggests medium-term selling pressure. With both Energy and Metals & Mining sectors under pressure, a test of primary support at 5120/5150 is likely.

ASX 200

The Aussie Dollar is also falling, having reversed below primary support at $0.8650 to signal a decline to $0.80*.

Aussie Dollar

* Target calculation: 0.87 – ( 0.94 – 0.87 ) = 0.80

Monetary Base and deflation

The Monetary Base consists of currency in circulation and commercial bank deposits at the Federal Reserve. Currency in circulation includes notes and coins both in circulation and held in the vaults of commercial banks. Commercial bank deposits at the Fed can be further broken down into required reserves and excess reserves. Excess reserves on deposit have soared — since late 2008 when the Fed started paying interest on reserves — to a level of $2.6 Trillion.

By varying the interest rate payable on excess reserves the Fed can manipulate the amount of currency in circulation. It is no longer reliant solely on Treasury and MBS purchases and sales to increase or decrease the money supply: these are merely one tool in the monetary tool-kit. So announcing that QE (security purchases) have ended does not mean that currency in circulation and the working monetary base (excluding excess reserves) will stop growing or will contract. That would cause deflationary pressure similar to the European experience. Growth, instead, is likely to continue provided that excess reserves are drawn down to compensate for cessation of QE.

US Monetary Base minus Excess Reserves and Currency in Circulation ROC

Deflationary pressures are unlikely to surface provided currency in circulation and the working monetary base continue to grow at above 5% a year. Only if real GDP grew at a faster pace (a problem we would like to have) would we encounter a problem.

Australia has similarly been keeping on the right side of 5% growth since early 2012. Provided this continues we should keep out of trouble.

Australia Monetary Base and Currency in Circulation ROC